Federal Home Loan Banks: Too Soon to Tell the Potential Impact of
Excess Stock Rule on the Affordable Housing Program (22-JUN-07,
GAO-07-878R).
Affordable housing organizations and Federal Home Loan Bank
(FHLBank) members have raised concerns that a Federal Housing
Finance Board (FHFB) rule limiting excess stock could adversely
impact FHLBank earnings. In particular, concerns have been raised
regarding the FHLBanks' Affordable Housing Program (AHP), which
subsidizes the cost of affordable housing with funds from the 12
FHLBanks, all of whom are required to contribute a minimum of 10
percent of their prior year's net earnings to the program,
subject to a minimum annual combined contribution of $100
million. Congress asked us to examine the impact of FHFB's rule
making on AHP. Specifically, this report describes (1) the
results of FHFB's rule making and the provisions of the final
rule on excess stock, and (2) the potential impact of the final
rule on AHP.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-07-878R
ACCNO: A71233
TITLE: Federal Home Loan Banks: Too Soon to Tell the Potential
Impact of Excess Stock Rule on the Affordable Housing Program
DATE: 06/22/2007
SUBJECT: Bank loans
Federal aid for housing
Federal funds
Financial institutions
Housing programs
Lending institutions
Mortgage loans
National banks
Stocks (securities)
Agency proceedings
Agency missions
Federal Home Loan Bank System
FHLB Affordable Housing Program
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GAO-07-878R
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June 22, 2007
The Honorable Christopher Bond
Ranking Member
Subcommittee on Transportation, Housing and Urban Development, and Related
Agencies
Committee on Appropriations
United States Senate
Subject: Federal Home Loan Banks: Too Soon to Tell the Potential Impact of
Excess Stock Rule on the Affordable Housing Program
Dear Senator Bond:
Affordable housing organizations and Federal Home Loan Bank (FHLBank)
members have raised concerns that a Federal Housing Finance Board (FHFB)
rule limiting excess stock could adversely impact FHLBank earnings.^1 In
particular, concerns have been raised regarding the FHLBanks' Affordable
Housing Program (AHP), which subsidizes the cost of affordable housing
with funds from the 12 FHLBanks, all of whom are required to contribute a
minimum of 10 percent of their prior year's net earnings to the program,
subject to a minimum annual combined contribution of $100 million.^2 You
asked us to examine the impact of FHFB's rule making on AHP. Specifically,
this report describes (1) the results of FHFB's rule making and the
provisions of the final rule on excess stock, and (2) the potential impact
of the final rule on AHP. On May 22, 2007, we provided your staff with a
briefing on the results of our work. Enclosure I is an updated version of
the briefing we provided.
^1Excess stock is stock that is held by a member and exceeds that member's
required minimum investment in FHLBank capital stock.
^2Financial Institutions Reform, Recovery, and Enforcement Act of 1989
(FIRREA), Pub. L. No. 101-73, S 721, 12 U.S.C. 1430(j)(5).
Background
In March 2006, FHFB issued a proposed rule that would require each FHLBank
to (1) maintain a minimum level of retained earnings, (2) limit the amount
of excess stock it could have outstanding, and (3) cease payments of
dividends in the form of stock (referred to as stock dividends). However,
in the final rule issued in December 2006, FHFB did not include a retained
earnings requirement but did include limits on FHLBanks issuing excess
stock and paying stock dividends.
The FHLBank System was created by the Federal Home Loan Bank Act of 1932
as a government-sponsored enterprise (GSE) to support mortgage lending and
related community investment. Through AHP, the 12 FHLBanks subsidize the
cost of affordable owner-occupied and rental housing targeted to
individuals and families with very low, low, and moderate incomes.^3 From
1990 through 2006, FHLBanks awarded a total of nearly $3 billion in AHP
funds through member institutions, such as community banks, for a wide
range of affordable housing projects. For 2006 specifically, FHLBanks
awarded a total of about $315 million in AHP funds.
Final Rule Places Limit on FHLBanks Issuing Excess Stock and Paying Stock
Dividends
The FHFB adopted a final rule in December 2006 limiting the ability of
FHLBanks to create member excess stock under certain circumstances. The
key features of the proposed rule were a limit on excess stock at each
bank to one percent of its total assets, an absolute ban on the payment of
stock dividends and sales of excess stock to members, and a requirement
that banks with outstanding excess stock greater than one percent of
assets develop a plan to reduce their excess stock to one percent. The
effect of the final rule is that it limits the ability of FHLBanks to
issue new shares of excess stock and pay stock dividends once the amount
of outstanding excess stock reaches a threshold of 1 percent of a
FHLBank's total assets.
The final rule addresses FHFB concerns about how excess stock could affect
the FHLBanks System's mission. FHFB officials stated that FHLBanks have
used cash from the sale of member excess stock to support capital market
investments. They also noted that while some level of such investment is
appropriate for liquidity and other purposes, high levels of excess stock
can create an incentive for FHLBanks to create large portfolios of
investments that are meant to provide a return on the excess stock, but
which do not necessarily further the FHLBank System's public purpose of
supporting mortgage lending and related community investment.
The FHFB also addressed safety and soundness concerns in its rule making.
Since FHLBanks have generally redeemed excess stock upon the request of a
member,
FHFB officials do not believe that member excess stock is a stable source
of capitalization, particularly when it is used to capitalize long-term
assets, and because FHLBanks could experience large-scale repurchase
(stock redemption) requests in a short period of time. FHFB officials also
stated that while investments funded through the issuance of excess stock
are intended to generate bank income, they add risk to a bank's balance
sheet and must be managed appropriately in order to be profitable.
Further, other factors, such as the type of investment and degree of
leveraging, also affect the level of earnings generated by each FHLBank's
investments through excess stock.
^3AHP subsidizes the cost of owner-occupied housing for individuals and
families with incomes at or below 80 percent of the area median income,
and rental housing in which at least 20 percent of the units are reserved
for households with incomes at or below 50 percent of area median income.
The subsidy may be in the form of a grant or a below-cost, or subsidized,
interest rate on a secured loan from a FHLBank to a member lender.
Too Soon to Tell Potential Impact of Excess Stock Final Rule
The final rule may have an impact on the FHLBanks' AHP, but FHLBank and
trade group officials stated it is too early to tell. Officials at two
FHLBanks told us that the final rule could limit the ability of FHLBanks
to increase capital over time since FHLBanks can no longer pay stock
dividends or issue excess stock once they reach the 1 percent threshold.
Paying cash dividends in place of stock dividends lowers the amount of
funds available to generate income through FHLBank investments. Since
FHLBanks are required to contribute 10 percent of the prior year's net
earnings to AHP, lower levels of FHLBank investments could lower net
earnings, which in turn reduce FHLBank contributions to AHP. As of the end
of September 2006, four FHLBanks had excess stock with a value greater
than 1 percent of total assets, and one of these was paying stock
dividends. This FHLBank paid a total of $205 million in stock dividends to
members during 2006. According to the FHLBank's officials, if this amount
had been paid in cash dividends, the resulting reduction in annual AHP
funding would have been about $1.2 million since the bank would have had
lower levels of investments to generate income. Overall, FHLBank and trade
group officials we interviewed said it is too early to tell what the exact
impact of the final rule on AHP will be. FHLBank officials stated that it
is too early to make an accurate assessment whether FHLBank capital growth
may decrease, by how much, and to what extent this could affect earnings
and contributions to AHP. Trade group officials stated there has not been
a noticeable impact on AHP subsidies for projects, but the situation could
change based on what happens to the banks over time.
Agency Comments and Our Evaluation
We provided a draft of this report to the Chairman of FHFB for his review
and comment. We received informal comments that are summarized in this
section. We also received technical comments that we incorporated into the
report where appropriate. In its comments, FHFB stated that our
description in the report that it's too soon to tell the potential impact
of the excess stock rule repeats, without independent analysis, arguments
made by certain FHLBank officials and trade group representatives.
Further, FHFB stated that the estimate presented in the report of the
potential reduction in AHP contributions at one FHLBank depends on a
number of assumptions, including a fixed leverage ratio, the pricing of
products, and the types of investments the FHLBank makes. FHFB also noted
that this estimate amounts to less than 1 percent of AHP funding by all
the banks in 2006. In the absence of a rule in place over a period of time
that limits the issuing of excess stock to members, we
lack a basis for determining to what extent the rule may affect each
FHLBanks' use of excess stock in financing investments, and to what extent
earnings could be affected by those investments. While the final rule
places limits on excess stock, we believe that the impact of actions taken
by FHLBanks to date based on the rule cannot be determined given that the
rule has been in effect only since the end of January 2007. Further, in
our report, we note that various factors, including the degree of
leveraging and type of investment, affect the level of earnings generated
by investments made through the sale of excess stock. Finally, the
estimate of the potential reduction in AHP contributions we report is for
one FHLBank. Rather than making a direct comparison to either system-wide
or FHLBank specific AHP funding, we provided the 2006 level of system-wide
AHP funding in the background section of our report.
FHFB also noted that two FHLBanks had income problems arising from
mortgage loans capitalized by excess stock and were operating under
written agreements in 2006, and that this capitalization of long-term
assets was one of the concerns it addressed in restricting excess stock.
We inserted in our report that one of the primary concerns FHFB had in its
formulation of the rule is the capitalization of long-term assets.
Scope and Methodology
To describe the results of the FHFB's rule making and the provisions of
the final rule on excess stock, we obtained and analyzed information on
FHFB's rule making for the proposed and final rule. We also reviewed
comment letters submitted by FHLBanks and trade associations addressing
the proposed rule and interviewed FHFB officials. To describe the
potential impact of the final rule on the FHLBanks' AHP, we reviewed
documentation on the possible impact of the final rule on the AHP. We also
interviewed officials from two FHLBanks, one of which was the most
affected by the rule, and officials from three trade associations--the
Council of FHLBanks, the Mortgage Bankers Association, and the National
Low-Income Housing Coalition. We conducted our work from February 2007
through June 2007 in accordance with generally accepted government
auditing standards.
- - - - - - - - - - - - - - - - - -
We are sending copies of this report to the Chairman of the Subcommittee
on Transportation, Housing and Urban Development, and Related Agencies,
Senate Committee on Appropriations; the Chairman and Ranking Member of the
Subcommittee on Transportation, Housing and Urban Development, and Related
Agencies, House Committee on Appropriations; and the Chairman of the FHFB.
We will also make copies available to others upon request. In addition,
the report will be available at no charge on the GAO Website at
http://www.gao.gov.
If you or your staff have any questions about this report, please contact
me at (202) 512-8678 or [email protected]. Contact points for our Offices of
Congressional Relations and Public Affairs can be found on the last page
of this report. Major
contributors to this report were John Wanska, Assistant Director; Tarek
Mahmassani; Barbara Roesmann, and Paul Thompson.
Sincerely yours,
William B. Shear,
Director, Financial Markets and Community Investment
Enclosure
Enclosure I: Potential Impact of Excess Stock Rule on the Federal Home
Loan Banks' Affordable Housing Program
(250332)
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